Paper loss

In finance a paper loss or paper gain is a hypothetical loss or gain on an investment. They are important components of the Financial Crisis of 2008. Paper losses in the U.S. stock market were $8.3 trillion in 2008, as the total value of all shares fell from $20 trillion in Jan. 2008 to $12 trillion in October. Paper losses hit the trillion-dollar level on several days in 2008. The stock markets in outher countries had even worse performances.

Suppose people bought stock XYZ in 2003 for $1000, watched it go to $1500 in 2008, then drop to $1000 again in 2008. Their "paper loss" is $500 but their real loss is zero since they are back where they started. People who bought at $800 still have made a $200 paper profit. People who bought at $1200, say, have a paper loss of $200. The paper loss or gain becomes real when they finally sell the stock.

The paper gains and losses are not reported as income on income tax returns. Real gains and losses are reported, and are known as "capital gains" or "capital losses." They are taxed at (typically) lower rates and are treated differently than income earned by salaries and wages.

The psychological impact of paper gains and losses is very important. People with large paper gains are likely to feel richer and to spend more money, while those with paper losses feel poorer and are more cautious. If people feel that the prices will keep falling they will become very cautious. Banks will stop lending to average customers, which is happening in 2008.

Very large paper gains came in the American real-estate bubble in 2001-2007. An ordinary 3 bedroom house in California that sold for $200,000 in 2001 might sell for $500,000 in 2007, and then dropped to $350,000 in 2008. Many people bought houses on speculation—they did not plan to live in them but planned to sell them and keep the profits. This speculation accelerated the rise in housing price, and accelerated the plunge after the bubble burst.